Megatrends

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The Impact of the 2018 Value Added Tax (VAT) on the Food and Drinks Industry in UAE and Saudi Arabia

Intro

Expected introduction of VAT in 2018 in 6 countries of Gulf Cooperation Council (GCC) which includes UAE, Saudi Arabia, Kuwait, Bahrain, Oman and Qatar, comes as a response to low oil prices and Governments seeking to diversify sources of revenue.

According to Euromonitor International’s Industry Forecast Model (IFM), value added tax will have significantly different impact on different consumer industries and in this blog post we will examine the impact on the region’s two largest economies (Saudi Arabia and UAE) and on two industries: Packaged Food and Non-alcoholic drinks.

There are number of food items expected to be exempt from VAT but GCC members have not yet ratified final agreement and the list of exempt goods is not confirmed. For the purpose of this analysis, we assume that all categories will incur an equal 5% rate.

Industry forecast model (IFM) by Euromonitor International

As VAT is expected to raise consumer prices, IFM price elasticity data can be used to evaluate its impact. While the impact of price increase on volume sales is generally negative, the impact of price increase on value sales can be either positive or negative depending on how elastic category sales are. When category price elasticity is low (category is price-inelastic), price increase leads to a value sales growth, as the decline in volume sold is lower than the increase in price in relative terms. Whereas, for price-elastic categories, the decline in volume will be larger than the increase in price, which will lead to a decline in revenues.

Short term impact

In the short term, consumers are expected to bear higher costs. Implementation of VAT will incur costs for everyone in the supply chain as companies need to adjust their accounting and reporting systems, train their staff, reprogram internal software etc. In response companies will try to, as experience from other countries show, transfer the costs to the final consumer.

Long term impact

The charts below show how category consumption (value terms) would change over five years in response to a 5% increase in price levels. This can be thought of as a long-run response and it is usually larger than the immediate short-term effect due to consumer habit persistence. Often, it takes time for people to adjust their purchasing habits as economic conditions change, and long-run elasticity allow for such dynamic effects. It should be noted that this is likely an upper limit of the effect, since in response producers and retailers may reduce the pre-tax prices and the overall price increase might be lower than 5%. The extent to which producers and retailers can share the burden of the tax depends on how competitive market is for each category, as competitive companies are already pricing close to marginal cost and may not have an ability to supply products at even lower prices and so the whole tax will be passed on to consumers.

Category analysis

According to our Industry Forecast Model, Dairy, Confectionary and Baked Goods are expected to be the most affected packaged food categories in the UAE and Saudi Arabia. For example, Confectionary sales in UAE are forecast to decline by 100 million US$ over 2018-2023 period when compared to the baseline forecast. To put it in perspective, this will represent the loss of more than 17% of Confectionary’s market size which in 2018 is estimated to reach 580 million US$

In Drinks industry, bottled water, juice and carbonates categories are expected to be hit the most with the introduction of VAT. For example, Carbonates in Saudi Arabia are forecast to decline by 376 million US$ over 2018-2023 period when compared to the baseline forecast. This is loss of 13% of Carbonates’ market size which in 2018 is estimated to reach 2.99 billion US$.

These categories are the most income and/or price elastic, and will thus be hurt more by lower consumer incomes and higher retail prices resulting from VAT introduction.